Why the state and local tax deduction will survive

Tax-reform is finally happening in Washington, and for the next several months you’re going to hear an endless stream of overwrought rhetoric about who it will hurt and who it will help.

We’re going to fast-forward to early 2018, when a final tax bill is likely to pass Congress and make this prediction: The state and local tax deduction will survive—but in diminished form.

This popular deduction, claimed by about one-third of all tax filers, costs Washington about $100 billion per year in foregone revenue. President Trump’s tax plan would eliminate the deduction, while cutting tax rates and the tax burden overall. The White House says all taxpayers would benefit, on net, although independent groups such as the Tax Policy Center say some people’s taxes might go up.

Lawmakers from states such as New York, New Jersey and California—where taxpayers rely most on the so-called SALT deduction—are fighting hard to keep the break, and they’ll probably get their way. “It will be reduced, not eliminated,” Douglas Holtz-Eakin, president of the American Action Forum and former director of the Congressional Budget Office said at the Yahoo Finance All Markets Summit on October 25.

“There will be an artful compromise,” added Greg Valliere, chief global strategist at Horizon Investments. “For the very, very wealthy, they may lose some of that break, but it will be preserved in some form.” The video above includes more expansive comments on the SALT deduction by both analysts.

Reducing or eliminating some tax breaks is an important part of tax reform, since, in theory, it would make the system fairer and generate new revenue that allows Congress to lower rates for everybody. But every tax break has a political constituency—and often, an army of lawyers fighting to defend it. Eliminating the SALT deduction would hit Democratic states harder than Republican ones, simply because states that lean blue tend to have higher incomes and more people who itemize deductions.

But there are still Republican districts in Democratic states, and as Yahoo Finance demonstrated earlier this year, there are relatively high portions of taxpayers claiming the deduction in swing states such as Virginia, Wisconsin, Colorado and Michigan. Harming taxpayers in those states could have electoral consequences Republicans would rather not invite—one reason determination to kill the SALT deduction could waver.

Other changes in the tax code could make the SALT deduction less compelling, however, leading fewer people to claim it. Trump wants to double the standard deduction, to $12,000 for individuals and $24,000 for married couples, which means more filers would claim it and fewer would itemize. That could leave the SALT deduction vulnerable to future tax-reform efforts—if we manage to get through the current one.